Question

Ariel, Inc., issued $60 million face amount of 9% bonds when market interest rates were 9.30% for bonds of similar risk and other characteristics. (a.) How much interest will be paid annually on these bonds? (b.) Will the bonds be issued at a premium or discount? Explain your answer. (c.) Will the annual interest expense on these bonds be more than, equal to, or less than, the amount of interest paid each year? Explain your answer.

Answer 1

a) interest that will be paid annually on bonds = $60 million * 9% = $5.40 million

b) the bonds will be issued at a discount.

reason - the bonds are paying 9% annually but the market is expecting 9.30%. since the bonds are paying less than the expectations of the market, the bondholers would want to pay less for these bonds. hence, the bonds shall be issued at a discount.

c) annual interest expense on these bonds shall be more than the amount of interest paid each year.

reason - the annual interest expense shall include, in addition to the amount of interest paid each year, the amortization of discount on bonds payable.

for example, the annual interest payment is $5.40 million and assuming that the annual discount amortization is $0.3 million, then the annual interest expense shall be $5.40 million plus $0.30 million i.e. $5.70 million